Ep. 5 | Capital Loss Harvesting
Download MP3Welcome to the Teaching Tax Flow podcast, where the goal is to empower and educate you to legally and ethically minimize taxes paid over your lifetime.
Speaker 2:Welcome everybody back to Teaching Tax Load, the podcast. I am John Trabolski, the cohost here. Standing to my right as always, as Chris likes to say, my right hand man. Chris Paciro, CPA, and everything else. How are you doing, Chris?
Speaker 3:I am wonderful. Happy holiday. Almost holiday season. How are you doing?
Speaker 2:Oh, don't skip forward too much. We just passed Halloween. We got turkey day coming up, and then then basically all the fun starts. But before we get off on too many sidetracks, we got a great topic for today. If you did not look into the show notes, stop being lazy.
Speaker 2:The first one, it's right in front of you. But if you didn't, I'm gonna tell you about it. Capital loss harvesting. So before I literally hand it over to Chris, the guy will give you everything you need to know about it. We won't really get into too too much detail or will, but either way, this show won't be extremely long, a little bit briefer than others.
Speaker 2:But, Chris, if we give well, first off, let's do a really your explanation of this, but then also let's tie in how this is so or how this is so important, but why this is so important now that we're at the end of the calendar year and how that really plays into annual tax planning.
Speaker 3:Absolutely. Capital capital gain and capital loss management is very important when it comes to tax planning and strategy, especially here in the last quarter of the year. So the timing of this is important. I don't know why we didn't do this in episodes one to four, but a real brief history on why we brought this up into the forefront on episode five. My nine year old son, Luke, him and his, baseball team buddies all collect baseball cards, and, admittedly, I do too.
Speaker 3:Some of the dads do. Anyway, he listens to a sports card collecting podcast. And part of the podcast, yeah, we turned our kids on to podcasts early, Jane. Yeah. I wish teaching Taxflow was his favorite podcast, but number two, I have to be sport card investor podcast.
Speaker 3:But, anyway He's better.
Speaker 2:Giving us a five star, or we're gonna have to have a little dinner chat with him.
Speaker 3:We're gonna talk with him. Yeah. We can take away his French fries from dinner. But, but Luke said, dad, on my podcast, they mentioned a CPA and how the value of these collectibles is is going down and and people are selling them even if they lost a lot of money. And it hit me.
Speaker 3:Capital loss harvesting. Some of these sport card collectors are obviously trying to take a tax deduction for the losses they've experienced in their investment. That could be a collectible, like a sport card, like a comic book. It could be a stock. It could be a bond.
Speaker 3:It could be some type of cryptocurrency. It could be any real estate. It could be any type of investment that you have experienced a loss of value.
Speaker 2:So, really, capital loss harvesting is exactly what it sounds. Right? Like, you you harvest a crop at the end of the year or or at the end of the season. So, basically, you're taking any of your investments that may have decreased in value, whether minimal or significant, but we can dive into that a little bit or or obviously their strategy around it. But you're really just collecting that, kind of getting it off your books and claiming that as a loss in this situation.
Speaker 2:Correct?
Speaker 3:Correct. And we're gonna tie this into the teaching tax flow ecosystem. So as we come into the year end, like we said, if you are a RAD diagnosis, meaning you are, in general, a high marginal tax rate, you are obviously looking for some type of tax deductions. And sometimes a deduction could be something that offsets, tip normal income or it could offset capital gain income. So when we're talking about REDD diagnosis, capital loss harvesting, that's in our book that and as you know, we diagnose prescribed as a capital harvesting capital losses as a prescription that we call an advanced prescription.
Speaker 3:So this is typically something you're gonna work with someone on your board of directors to execute, typically your your tax professional and your financial adviser, and it's also a plus. Well, plus means that it's not you're not deploying any additional assets to harvest the loss. You're just repositioning the assets you have, and because you're recognizing a capital loss, you're recovering tax dollars. So the tax flow exceeds the cash flow, and that's the capital loss harvesting. Now we're gonna talk about when it makes sense and some of the limitations, because there are limitations as far as, one, how much in capital losses you can recognize in a year, And two, what type of capital losses that, that could be harvested?
Speaker 2:And so as far as for executing on on this component of strategy, is this something that I mean, you really don't wanna do anything shooting from the hip. You know, I I really there's never a great time for that with anything. But when would be a bad time to do this? Is this something you you you know, you wanna be sitting out for some drinks on December 31 and you're, oh, boy. This is a great time to do this.
Speaker 2:Talk to us talk to us through that a little bit. I know that's kind of the extreme, but, obviously, you're tomorrow's a new day when you're looking at the other year.
Speaker 3:Correct. Right? Well, one thing to get I first of all, I'm I think I'm gonna try try to hang out with you on New Year's. Every example you have is some guy at 10PM on New Year's with a with a martini.
Speaker 2:Admittedly, actually, I don't even think I was awake the past couple of years, but so clearly, I'm not thinking about this when I was sleeping.
Speaker 3:Let's make let let's lay out some some ground rules here. You never want the tax tail to wag the dog. So we're not harvesting capital losses unless it makes sense for us in our bigger financial and tax planning picture. Okay? When you have losses and let's let's just use the example of a brokerage account right now.
Speaker 3:So you have stocks, bonds, mutual funds, and account. If the value of the stocks, bonds, mutual funds, let's just call them assets, is less than what your cost basis is, in general what you paid from, there are some exceptions when you inherit assets, you have unrealized losses. That means they've got the the prices or the value has gone below what you paid. You might have unrealized gains as well. From a tax perspective, you do not pay tax on your unrealized gains, and you don't do not get a deduction from your unrealized losses.
Speaker 3:So the strategy of harvesting capital losses means that you're actually recognizing or realizing that capital loss.
Speaker 2:So breaking it down and dumbing it down a little bit. So say let's just use an even number. Let's say you invested a hundred thousand, and it went down 10%. So now now your your value is 90. Right?
Speaker 2:And let's just say that's kind of all all encompassing. So say you harvest your capital losses. Is your new base 90 going into the next year? How how does that how does how does harvesting in one year affect the following year?
Speaker 3:Well, that's a good question. We're gonna talk about some of those limitations. So what happens is is the year you the year that you harvest the capital loss is the year from a tax perspective that you recognize the capital loss on your tax return. Alright? So that's step one.
Speaker 3:Step two then is, how much of that capital loss can you utilize in the current year? So capital losses first offset any capital gains that you have that year. So if you have a large capital gain, capital loss harvesting is very attractive. If you do not have any capital gains or your capital losses that you that you realize exceed your capital gains, there's a limit of how much you can deduct in the current year. For joint tax filers, that's $3,000 For single head of household and married filing separate, that's $1,500 So that that access realized loss amount is limited.
Speaker 3:Now let's say, for example, you have no capital gains. You have a $10,000 realized capital loss this year, and you're married. Dollars three thousand of that would be deductible in 2022. The remaining $7,000 doesn't go away. It gets pushed into the future to be utilized against future capital gains, or you get the $3,000 deduction in that case until it expires.
Speaker 2:Excellent. So you have so if you if you obviously have an amount over what that limitation is, you're pulling from that at your your max within the limitation for the for the current year. But that's a great point that they don't it's not the the use it or lose it, you know, one time deal. Right? Exactly.
Speaker 2:Them out as needed.
Speaker 3:It's capital loss carry forward, and that's just a tax tip. If you change tax softwares, if you change tax preparers, make sure that your new preparer or the new software that you're using, review your prior year return because I've seen instances where if if the CPA firm doesn't do a proper onboarding or the person changes from one tax software to the other, that they forget they had this big capital loss carry forward. And the IRS I've yet to see the IRS remind someone of it.
Speaker 2:Oh, yeah. Darth Vader as we call them at a at a later episode most likely. Right?
Speaker 3:Exactly. So that's why harvesting these gains or realizing these rather, harvesting these losses or realizing the losses is valuable in the current year. Not only that, but you still get to use those losses in the future year. Why is that important? We're gonna talk about this in a future episode.
Speaker 3:But in general, the set sentiment is that tax rates are gonna increase in the future. So that $3,000 deduction in 2029, if it carries forward, is more valuable than now.
Speaker 2:So we've been looking at I I know you mentioned crypto specifically. So that's that's something that's newer newer on the table, I'd I'd imagine, in your world just like everybody else on the investment side. But looking at something that's a little more commonplace. So looking at IRAs, four zero one k's, so those being retirement accounts. So how much and I know we we teased a little bit there, but how much does this really apply to retirement accounts?
Speaker 2:But not not just how much does it apply, but is it the same strategy in place with that? Talk us a little bit through that because I'm sure that's something that a lot of listeners have, that they might not realize, you know, capital loss harvesting applies to that or or
Speaker 3:anything around it. That's a great point. So, unfortunately, losses that have occurred in a retirement account, if you if you realize them, are not deductible on your personal tax return because that those assets are growing tax deferred in the in the example of a of an IRA or a four zero one k and a Roth are growing tax free. So those those gains and losses that are realized in those retirement accounts really don't play
Speaker 2:a role in the tax planning piece. So those are really so not only are your your taxes deferred, so are your gains and losses. Is am I hearing that correct? Or or No. That way?
Speaker 3:It not really. What's happening is if you have a loss in a retirement account and you realize the loss or if you have a gain in a retirement account and you realize the gain, that has nothing to do with your personal return. Perfect. Okay. You recognize income from retirement accounts assuming that they're tax deferred when when you take money out of the account.
Speaker 3:Exactly. What happens in the account is irrelevant to harvesting capital gains.
Speaker 2:You're just kinda watching from the sidelines for for the most part.
Speaker 3:Exactly. I mean, it's an important part of your financial plan, but not from a tax perspective. The the only thing I would mention on that is and this this kinda ties into, another tax planning opportunity. And we we talk about pairing, you know, pairing different, strategies. But if you do have assets that have significantly been reduced and you in in an IRA or a four zero one k and you feel like they will go up later, you might wanna convert those to a Roth and just pay the tax and lock in the tax on that depreciated value.
Speaker 3:But, again, let's focus on capital loss harvesting because we are any capital losses that occurred in the calendar year that you're in are reported on that calendar year's tax return. We talked about some of the that these losses that are harvested within retirement accounts really don't play a role in the strategy. The other thing you have to be aware of is something called wash sale rules. And what that means is that if you recognize or realize a capital loss, to be able to deduct that loss, you have to wait a a period of time before you can reacquire that asset. And that's probably something that a
Speaker 2:lot of individuals don't know as well too. And and to be totally honest, this is actually a new a new term to me as well. So we're talking about specifically wash sale rules. So if anybody wants to take a guess at what that means, I'm I'm sure I'm sure it has something to do with the name itself. But but walk us through that a little bit.
Speaker 2:I mean, give us you know, obviously, you mentioned that there's a time a time line or timeline or a timetable involved in that. So what would we be looking at with the wash sale rule?
Speaker 3:Well, let's say you sell a a stock for a loss and you realize that capital loss. The wash sale rules prohibit, selling that investment for a loss and replacing it with the same or substantially identical investment thirty days before or after the sale.
Speaker 2:So you can't sell I can't unload all my crypto and then purchase it again in twenty four hours.
Speaker 3:Well, you can, but you're not gonna be able to deduct that loss. Bingo. Okay. Definitely take a look and talk to the people on your centers of influence about those wash sale rules. Now there are that term substantially identical is something to examine.
Speaker 3:So if you if you like something in in a similar industry, there's a ways to reposition those assets to avoid that substantially identical investment category. K. So or, you know, again, the plan we we say, don't let the tax tail wag the dog. The but the point is really look at your situation, especially in this year that we're coming to the end of twenty twenty two where there's been a lot of fluctuation, not only you mentioned in crypto, but in in the stock market where there could be some capital losses that have been that are ripe to be realized. And as long as that fits in there, like I said, your overall investment and tax plan, we strongly recommend harvesting those losses, especially if you have a law if you have a capital gain in that given year.
Speaker 2:And this, and not to not to to, you know, beat the dead horse, but, yeah, this I'm I'm super intrigued with this wash sale rule because if it's something that you're not familiar with, you're not planning for, that could really be a rude awakening come tax time. Right? So that thank you for bringing that up. That's a that's a great example.
Speaker 3:Absolutely. And we'll put a link to wash sale rules in the show notes, so that you could check that out. Wanna wrap up by by mentioning one thing that you mentioned. We talked about so big picture, why do we like capital loss harvesting? Red diagnosis, it's a plus.
Speaker 3:So it doesn't cost you cash outlay. It's actually a plus because you recover tax dollars that would be paid. It's an advanced tax strategy. So typically, you can you you are working with a professional to execute it. Some people could do it on their own.
Speaker 3:The pretax account like an IRA or four zero one k are not gonna qualify for the capital loss harvesting. And cryptocurrency, as long as it's not in some type of retirement account, can be sold and those capital losses be realized. So any capital loss. So you could have a capital loss from a piece of cryptocurrency and offset a gain a capital gain from the sale of a piece of raw land or rental property. And that's where we really have to look at the tax, low versus cash flow.
Speaker 3:And this is why we wanted to move this other than Luke mentioning these these collectibles, this is why we wanted to move this episode up so that people have at least a thirty day window to take a look at their portfolio, take a look at their tax projection, and figure out, should I harvest capital losses this year? Final thing to remember, if your capital losses exceed your capital gains, it's okay. You could still deduct if married three thousand, if not 1,500 in the current year. The rest carries forward. And a lot of times, we have taxpayers we talk to that maybe sell property on land contracts.
Speaker 3:So they already know they're gonna have capital gains built in to their plan moving forward. So it's okay to have a have that tax that loss carrying forward. It doesn't go away.
Speaker 2:So Excellent. Well, thank you for diving into that, and thank you everybody for joining in on this show as we dive into capital loss harvesting and the wash sale rule. I think that that was great. It was a great piece of advice, great piece of, you know, info, little nuggets to take with you. And, again, thank you everybody for joining us.
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Speaker 2:It's just hello@teachingtaxflow.com. Shoot us any thoughts, any questions. We would love to hear from you. But I can't forget about saying, I know I know your son, I he had to have left us a five star review. I find it hard to believe that he could have.
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Speaker 3:Exactly. And I will make sure Luke does that.
Speaker 2:Thank you.
Speaker 3:Remember to rate, review, subscribe. Thanks for your time, and we will talk to you in episode six.
Speaker 2:Excellent. Thank you, everybody, and we will see you next week as always.
